by Martin T. McGuinn,
Kirby & McGuinn APC

he Placer Foreclosure versus Aflalo case involves a trustee’s decision to delay distributing surplus funds after a foreclosure sale where the entire surplus belonged to the borrower. Surplus funds are funds generated at a foreclosure sale from a third-party bidder or the foreclosing beneficiary which exceed the amount due the foreclosing beneficiary and the costs of the foreclosure, including trustee fees and costs. See Civil Code 2924k (a) (1) and (2). The legislature has provided a statutory procedure to give notice to parties entitled to receive the surplus an expedited procedure to determine claims to the funds using Judicial Counsel forms.2 A hearing on the claims must be calendared within 90 days after the petition for distribution is filed with the court. See Civil Code 2924j

Placer Foreclosure conducted a foreclosure sale on real property located in Malibu, California. Not surprisingly, the borrower, Aflalo challenged the validity of the sale. Aflalo believed that the proceeds of a prior refinancing of several loans by Aflalo had were sufficient to pay off any obligation secured by the Malibu property and that the trust deed securing the Malibu property should have been re-conveyed at the time of the prior refinancing.

The appellate court in the Placer Foreclosure (“Placer”) case strictly interpreted the language of the statute governing the priority for distributing surplus funds generated at a foreclosure sale.3 However, critically not considered or addressed is the practical impact the ruling will have on parties in future cases. The Court upheld a trial court ruling that because the foreclosure sale purchaser, Pro Value Partners (“PVP”) was not a party listed in Civil Code Section 2924k (a) as an entity entitled to claim an interest in the surplus funds, the trustee, Placer, had no right to either withhold the surplus funds despite pending litigation seeking to set aside the foreclosure or to file an interpleader action as the only claimants to the funds were the borrower, Aflalo and PVP. Because PVP was not entitled to the funds, Placer had no right to withhold the surplus funds from Aflalo. The surplus funds generated by the sale of the Malibu property exceeded $974,000.00. The Placer decision’s impact on lenders is significant because in cases where there are no liens junior to the foreclosing trust deed, the foreclosure trustee will have no choice but to promptly4 release the surplus funds to the borrower or borrower’s counsel.5

Initially, Aflalo’s counsel agreed with the trustee and the beneficiary to keep the surplus funds on deposit with the trustee because the borrower had filed a separate action seeking to set aside the sale of the Malibu property. Aflalo later obtained new counsel who demanded the surplus funds, Placer decided to file an interpleader action (cross-complaint) and sought to deposit the surplus because Placer had “no interest in the Surplus and is indifferent with respect to which Defendant, or combination of Defendants, should receive the Surplus.” Id. p. 1112.

Aflalo filed a demurrer (motion to dismiss) the interpleader complaint on the ground Placer did not face multiple liability over the surplus. The trial court granted the demurrer finding that Placer did not face multiple liability from PPV because PPV was not entitled to the surplus funds as PPV was not a party listed in either Civil Code 2924b (c) or Civil Code 2924k (a) (2) or (3). “Placer contends that the interpleader complaint was proper because Placer was faced with liability from Pro Value if it distributed the surplus funds to Aflalo. We reject this contention. Placer could safely distribute the surplus funds to Aflalo as required by statute without any risk of multiple liability.” Id. p. 1113-1114. The foregoing language relieves trustees from liability to a third party bidder if the trustee provides the surplus funds to the borrower and the borrower subsequently sets aside the sale but has spent the bidder’s money when the sale is set aside.6 The court was critical of Placer’s decision to file the interpleader holding that “Placer did not face a valid threat of double vexation because Pro Value’s claim was against Aflalo, not Placer.” Id. p. 1115.

The lender knowing that a substantial sum will be paid to the borrower has a decision to make about whether to proceed to sale or work out a resolution with the borrower. If the sale is set aside in the future, the lender has to consider the possibility it will also have to return the payoff amount back to the bidder. However, where the sale is to a third-party bidder, the borrower’s ability to set aside the sale is limited to cases where the sale is void not voidable.7 Procedural defects in the sale process do not cause a third party sale to be set aside. The recitals regarding notice and compliance with statutory procedures are conclusive with respect to a third-party bidder.8

Thus, where the property generates a significant surplus for the borrower he or she will have prompt access to the surplus funds significantly increasing the borrower’s ability to litigate the validity of the foreclosure sale. In cases where the likelihood is that the borrower will receive a substantial surplus, the lender has a series of strategic decisions to make prior to conducting the sale. First, the lender must familiarize itself with the Trustee’s Sale Guaranty (“TSG”) prepared by the title company assisting the beneficiary and trustee with the sales process to determine whether there are junior liens. Title companies regularly update the foreclosure trustee throughout the process to identify any new liens created after the Notice of Default or discovered thereafter. The updates are typically requested at the time of authorization to proceed with the foreclosure, when the Notice of Sale is prepared, when the sale is about to be conducted, and after sale postponements or after a delay due to bankruptcy or court order.

It is also important to keep in mind that not all liens against the property are created equally and some liens have priority based upon a statute rather than the date of recording.9 Unless a judgement lien holder has recorded a Request for Notice under Civil Code Section 2924b it is not entitled to notice of the foreclosure proceeds nor is it entitled to notice of the foreclosure. See Civil Code Section 2924b (c) (2) (A) to (F).10 In addition, the sole case interpreting Civil Code 2924k held a judgment lien holder’s failure to record a Request for Special Notice prevented it from recovering from the surplus and all funds were paid to the borrower. See Banc of America Leasing and Capital, LLC, v. 3 Arch Trustee Services, Inc. (2009) 180 Cal. App. 4th 1090, 1103.

The lender should consider whether going to sale and providing a disgruntled borrower with the means to provide a significant fight justifies getting the loan paid off. The borrower will receive the surplus funds in these cases in 60 to 90 days from the date the Trustee’s Deed Upon Sale was executed. See Civil Code Section 2924j(a). A sophisticated borrower knows that he/she is getting substantially less from the proceeds of the sale than the borrower would receive from a voluntary sale. As such, the borrower will use the surplus to fight for damages because they did not receive the entire amount of its equity in the foreclosed property. If the borrower is willing to sell the property, a basis for a forbearance agreement can be put in place.

Failure to determine whether junior liens will eat up any surplus funds generated by the sale will determine the quality of the fight over the lender’s decision to foreclose.

Endnotes

1. Placer Foreclosure v Aflalo (2018) 23 Cal. App. 5th 1109.
2. In this case, because Placer held the funds longer than Civil Code 2924j allows, Placer filed a complaint in interpleader which is governed by Code of Civil Procedure 386.
3. Civil Code Section 2924k (a) (1) to (4).
4. The time within which the trustee must act is covered by Civil Code Section 2924j.
5. While each trustee may choose to make the decision to make the surplus funds check payable jointly to the borrower and the attorney or to an attorney’s trust account, the author strongly advises to make any surplus funds check payable to the borrower exactly as title was held on the date of sale. The reason is that the borrower can negotiate the check and pay it to the attorney if the borrower chooses to do so. Once payable to the borrower what the borrower chooses to do with the check is the borrower’s choice and the trustee and its beneficiary have no exposure if they comply strictly with the statute and pay the owner of record at the time of the sale.
6. As a practical matter because the claim to set aside the sale is one in equity, the trial court is unlikely to set aside the sale unless the entire amount paid by the successful bidder is repaid to it.
7. See generally, Ram v OneWest Bank FSB (2015) 234 Cal. App. 4th 1, and Residential Capital v Cal-Western Reconveyance Corp. (2003) 108 Cal. App. 4th 807 for a through discussion of the void vs. voidable permitting a sale to be set aside where a third party bidder is the purchaser.
8. See Bank of America v La Jolla Group II (2005) 129 Cal. App. 4th 706.
9. A discussion of the vicissitudes of lien priority is beyond the scope of this article.
10. Most trustees as a matter of courtesy (and caution) mail notices to parties who may not be strictly speaking entitled to notice under Civil Code 2924b (c) (2) (A) to (F), thus avoiding arguments from said junior lienholders and borrowers or owners about the notice issues.